10-Q 1 g70685e10-q.txt ESHARE COMMUNICATIONS, INC. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . ---------------- ----------------- Commission file number 0-22317 ------- eshare communications, Inc. (Exact Name of Registrant as Specified in Its Charter) GEORGIA 58-1378534 (State or Other Jurisdiction of Incorporation (I.R.S. Employer Identification or Organization) Number) 5051 Peachtree Corners Circle Norcross, Georgia 30092-2500 (Address of Principal Executive Offices) Registrant's telephone number, including area code: (770) 239-4000 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock, no par value, outstanding as of August 8, 2001: 21,931,477 shares. 2 PART I - FINANCIAL INFORMATION

2 3 PART I - FINANCIAL INFORMATION Item 1. Financial Statements eshare communications, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) (unaudited)

The accompanying notes are an integral part of these consolidated statements. 3 4 eshare communications, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except for per share data) (unaudited)

The accompanying notes are an integral part of these consolidated statements. 4 5 eshare communications, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)

The accompanying notes are an integral part of these consolidated statements. 5 6 eshare communications, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollar and share amounts in thousands) (unaudited) 1. Basis of Presentation The unaudited consolidated financial statements presented herein have been prepared in accordance with accounting principles generally accepted in the United States applicable to interim financial statements. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of our management, these consolidated financial statements contain all adjustments (which comprise only normal and recurring accruals) necessary to present fairly the financial position as of June 30, 2001 and 2000. The interim results for the three months and six months ended June 30, 2001 are not necessarily indicative of the results to be expected for the full year. These statements should be read in conjunction with our consolidated financial statements for the fiscal year ended December 31, 2000, as filed in our Annual Report on Form 10-K for the year ended December 31, 2000. We have reclassified the presentation of certain prior period information to conform to the current presentation format. 2. Principles of Consolidation The accompanying financial statements include our accounts and our wholly owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation. 3. Revenue Recognition We generate product revenues primarily from the sale of integrated systems, which are comprised of both hardware and software and software licenses. Our service revenues are generated from maintenance contracts that include support, parts, labor, and software update rights as well as fee-based installation, training, hosting, consulting services and the licensing of patents. We recognize revenue in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended by SOP 98-9, Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition" and Emerging Issues Task Force Issue 00-03, "Application of AICPA SOP 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity's Hardware." We recognize product revenues when persuasive evidence of an agreement exists, the product has been delivered, the license fee is fixed and determinable and collection of the fee is probable. Revenues from maintenance contracts are deferred and recognized ratably over the term of the contractual support period, which ranges from one to four years. Consulting revenues are primarily related to extended services performed under separate service arrangements during the installation period. Revenues from consulting, hosting, installation, and training services are recognized as the services are performed or over the hosting period, if applicable. In contracts where product and services are bundled together, revenue is allocated to each element of the contract. Revenues from patent settlements are recognized as other income when received. Revenues from patent licenses are recognized per the contract terms and in accordance with SAB 101. Certain of our sales contracts provide for certain payment terms normally based upon signing the contract, customer receipt of the product, and commencement of operation of the customer's system. Deferred revenues primarily relate to products that have not yet been delivered and maintenance services, which have been paid by the customers prior to the performance of those services. Deferred revenues were $9,823 and $11,463 at June 30, 2001 and December 31, 2000, respectively. 4. Inventories Inventories are stated at the average cost or market. Cost includes raw materials, labor, and overhead. Market is defined as replacement cost for work in progress and raw materials and net realizable value for finished goods. 6 7 Inventories consist of the following at:

5. Net loss per share Net loss per share is computed using the weighted-average number of common stock and diluted common stock equivalent ("CSE") shares from stock options (using the treasury stock method) outstanding during each period. CSEs are not included in periods which they are antidilutive. The following table presents the components of diluted weighted average shares outstanding.

7 8 6. Other Comprehensive Income (Loss) Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The changes in the components of other comprehensive loss are reported as follows:

7. Business Segment and Geographic Area Information We are a multinational business operating in two segments, telephony and Internet. We have adopted Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information" (SFAS 131). The adoption of SFAS 131 requires the presentation of descriptive information about reportable segments that is consistent with that made available to our management to assess performance. The results of these business segments are as follows:

8 9 The following represents our total revenues and long-lived assets based on geographic location for the three and six months ended June 30, 2001 and 2000:

8. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board approved Statement of Financial Accounting Standard No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 prospectively prohibits the pooling of interest method of accounting for business combinations initiated after June 30, 2001. SFAS No. 142 requires companies to cease amortizing goodwill that existed at June 30, 2001. This amortization of existing goodwill will cease on December 31, 2001. Any goodwill resulting from acquisitions completed after June 30, 2001 will not be amortized. SFAS No. 142 also establishes a new method of testing goodwill for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The adoption of SFAS No. 142 will result in our discontinuation of amortization of our goodwill; however, we will be required to test our goodwill for impairment under the new standard beginning in the first quarter of 2002, which could have an adverse effect on our future results of operations if an impairment occurs. 9. Subsequent Event On July 8, 2001, we entered into an agreement to merge with and into a wholly-owned subsidiary of divine, Inc. ("divine"), a provider of web-based technology, professional services and managed application capabilities. Following the proposed merger, we will be a wholly-owned subsidiary of divine. Additional information about the merger is contained in Item 5 of Part II of this Quarterly Report on Form 10-Q. 9 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollar and share amounts in thousands) Overview eshare communications, Inc. ("eshare", "we", "us" or "our") is a leading provider of customer interaction management software applications. Our solutions support voice, e-mail, live interaction/chat and hosting services for approximately 2,500 call centers, e-businesses, application service providers, Internet service providers and portals in approximately 40 countries. Our solutions enable real-time interactive communications and services, both voice based and over the internet, and include customer service and support, customer self-service, instant messaging, live conferencing and events, distance learning, community chat, threaded discussion forums and a variety of custom integration tools. Organizations use our applications and services to implement strategies for customer interaction that increase the value derived from their customers by enhancing customer acquisition and retention activities, while reducing costs and improving agent productivity and effectiveness. We offer ongoing maintenance support of our products. We also offer fee-based installation, integration, training, hosting and consulting services through our expert services organization. Certain statements contained in this filing are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, including but not limited to statements related to plans for future business development activities, anticipated costs of revenues, product mix and service revenues, research and development, and selling, general and administrative activities, and liquidity and capital needs and resources. Such forward-looking statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Investors are cautioned that any forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. A discussion of certain risk factors that may cause actual results to differ from these forward-looking statements can be found in Exhibit 99.1 attached to this Quarterly Report on Form 10-Q. Results of Operations Revenues Product. Product revenues for the quarter ended June 30, 2001 were $7,989 as compared to $13,200 for the same period ended June 30, 2000, a decrease of $5,211, or 39.5%. Revenue from the sale of telephony product decreased to $6,576 for the quarter ended June 30, 2001 from $8,651 in the quarter ended June 30, 2000, a decrease of $2,075 or 24.0%. Sales of internet product decreased to $1,413 for the quarter ended June 30, 2001 from $4,549 in the quarter ended June 30, 2000, a decrease of $3,136 or 68.9%. For the six months ended June 30, 2001, product revenues decreased $7,804 or 30.2% to $18,063 as compared to product revenue of $25,867 for the six-month period ended June 30, 2000. Revenue from telephony product decreased $3,198, or 17.9%, to $14,684 in the six-month period ended June 30, 2001 as compared to telephony product revenue of $17,882 for the six-month period ended June 30, 2000. This decrease is principally due to the current downturn in capital spending as the United States economy slowed during the period and ongoing competitive pricing pressures within the call center industry. Internet product revenues decreased $4,606, or 57.7%, from $7,985 for the six months ended June 30, 2000 to $3,379 for the six months ended June 30, 2001. This decrease resulted primarily from a downturn in the e-commerce market place. Service. Service revenues increased by $2,533, or 31.3% to $10,634 for the quarter ended June 30, 2001, as compared to service revenues of $8,101 for the quarter ended June 30, 2000. Service revenues increased by $3,769, or 23.7% to $19,659 for the six months ended June 30, 2001 from $15,890 in the comparable prior year period. Increased maintenance and consulting service revenue was the primary source of the new service revenues. Cost of Revenues Product. The cost of product revenues include the cost of material, fees paid to third parties for outsourced hardware assembly and the cost of sublicensing third-party software. The cost of product revenues for the quarter ended June 30, 2001 was $1,261, a decrease of $1,373, or 52.1%, as compared to $2,634 for the quarter ended June 30, 2000. The cost of product revenue for the six-month period ended June 30, 2001 was $3,840, a decrease of $1,647, or 30.0%, as compared to a product cost of $5,487 for the six-month 10 11 period ended June 30, 2000. This decrease in product cost is principally the result of the mix of products sold, which included a higher percentage of software only upgrades for our existing telephony customers and also was the result of the decline in absolute dollar sales of product. The cost of product revenue as a percentage of related product revenues was relatively unchanged for the comparable six-month periods. Service. The cost of service revenues primarily consist of employee-related costs and outsourcing costs for customer support, consulting and field service personnel, as well as fees paid to third parties for installation services and post installation, help desk, and hardware maintenance services. Our cost of service revenues for the quarter ended June 30, 2001 increased to $4,947, or 46.5% of related service revenues, as compared to $4,823 or 59.5% of related service revenues for the quarter ended June 30, 2000. Cost of service revenues increased to $10,707 or 54.5% of related service revenues for the six months ended June 30, 2001 from $8,982 or 56.5% of related service revenues for the six-month period ended June 30, 2000. This increase in cost of service revenues is related to the addition of costs to support Internet product services plus investments to increase our customer support to a global, 24 hours a day, 7 days a week coverage. Operating Expenses Engineering, research and development. Engineering, research and development expenses primarily consist of employee-related costs for engineering personnel involved with Internet and telephony software product development. Also included are outside contractor costs for development projects. Engineering, research and development expenses decreased by $250, or 9.7%, to $2,339 in the quarter ended June 30, 2001, as compared to $2,589 in the quarter ended June 30, 2000. Engineering, research and development expenses decreased by $284, or 5.4%, to $4,980 in the six-month period ended June 30, 2001, as compared to $5,264 for the six-month period ended June 30, 2000. Engineering, research and development costs increased as a percentage of product revenue to 27.5% of product revenues for the six-month period ended June 30, 2001, as compared to 20.3% of product revenues for the six-month period ended June 30, 2000. We continue to invest heavily in product development activities as we combine the telephony and Internet products into a seamless customer interaction management solution for our customers. As a result, engineering, research and development costs have increased a percentage of product sales. Selling, general and administrative. Selling, general and administrative expenses consist primarily of employee-related costs for sales, marketing, administrative, finance and human resources personnel. Also included are marketing expenditures for trade shows, advertising, other promotional expenditures, as well as depreciation and bad debt expenses. Our selling, general and administrative expenses decreased by $1,877, or 14.1%, to $11,446 in the quarter ended June 30, 2001, as compared to $13,323 in the quarter ended June 30, 2000. Selling, general and administrative costs decreased by $1,950 or 7.7%, to $23,539 for the six-month period ended June 30, 2001 from $25,489 for the six months ended June 30, 2000. We intend to continue cost cutting efforts and expense control. Other Income (Expense), Net. Other income (expense), net decreased by $162, or 117.4%, to a loss of $24 in the quarter ended June 30, 2001, as compared to income of $138 in the quarter ended June 30, 2000. Other income (expense), net increased to $349 for the six-month period ended June 30, 2001 from $250 for the six-month period ended June 30, 2000. This increase resulted from not having to make interest payments on debt for the period ended June 30, 2001 as we did in the comparable period. Income Tax Provision (Benefit). For the quarter ended June 30, 2001, we recorded a tax benefit of $502 as compared to a tax benefit of $695 for the quarter ended June 30, 2000. For the six months ended June 30, 2001, we recorded a tax benefit of $1,798, as compared to a tax benefit $1,157 for the six months ended June 30, 2000, as a result of having a larger operating loss for the six-month period ended June 30, 2001. Financial Condition Total assets at June 30, 2001, were $62,608, a decrease of $10,264 over total assets of $72,872 at December 31, 2000. This decrease was primarily due to a decrease in accounts receivable as well as a decrease in prepaid expenses and other. Current liabilities were $21,475 at June 30, 2001, down from $28,482 at December 31, 2000. This decrease was primarily due to payments of accounts payable and accrued liabilities. Liquidity and Capital Resources At June 30, 2001, we had $13,983 in cash, cash equivalents and marketable securities, compared to $14,727 as of December 31, 2000. Cash decreased due to payments of accounts payable and accrued expenses. Net cash provided by investing activities included the 11 12 sale of $2,766 of marketable securities, offset by the purchase of property and equipment of $1,208. Net cash provided by financing activities of $148 was primarily due to the proceeds of the issuance of common stock through our option program and employee stock purchase plan. Our working capital was $18,537 at June 30, 2001, as compared to $21,622 at December 31, 2000, a reduction of 14.2%. We believe that existing cash and cash equivalents will be adequate to meet our cash requirements for at least the next twelve months. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board approved SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 prospectively prohibits the pooling of interest method of accounting for business combinations initiated after June 30, 2001. SFAS No. 142 requires companies to cease amortizing goodwill that existed at June 30, 2001. This amortization of existing goodwill will cease on December 31, 2001. Any goodwill resulting from acquisitions completed after June 30, 2001 will not be amortized. SFAS No. 142 also establishes a new method of testing goodwill for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The adoption of SFAS No. 142 will result in our discontinuation of amortization of our goodwill; however, we will be required to test our goodwill for impairment under the new standard beginning in the first quarter of 2002, which could have an adverse effect on our future results of operations if an impairment occurs. Subsequent Event On July 8, 2001, we entered into an agreement to merge with and into a wholly-owned subsidiary of divine, Inc. ("divine"), a provider of web-based technology, professional services and managed application capabilities. Following the proposed merger, we will be a wholly-owned subsidiary of divine. Additional information about the merger is contained in Item 5 of Part II of this Quarterly Report on Form 10-Q. 12 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk Foreign Exchange During the three and six months ended June 30, 2001 total revenues from our international operations were approximately 32.1% and 26.7%, respectively, of our total revenues for all operations. Our international business is subject to risks typical of an international business, including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors. The effect of foreign exchange rate fluctuations on our operations during the second quarter of 2001 was not material. During these periods, we did not actively participate in any foreign currency hedging strategies. There can be no assurance that future fluctuations in currency exchange rates will not have a material adverse impact on our future international relations. Interest Rates We invest our cash in a variety of financial instruments, including taxable and tax-advantaged variable rate and fixed rate obligations of corporations, municipalities, and local, state and national governmental entities and agencies. These investments are denominated in U.S. dollars. Cash balances in foreign currencies are operating balances. Interest income on our investments is carried in "Other income (expense), net" on the Consolidated Statements of Operations. We account for our investment instruments in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). All of the cash equivalents and short-term investments are treated as available-for-sale under SFAS 115. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if forced to sell securities which have seen a decline in market value due to changes in interest rates. The weighted-average interest rate on investment securities at June 30, 2001 was approximately 3.93% based on short-term investments. The fair value of securities held at June 30, 2001 was $4.4 million. 13 14 PART II. OTHER INFORMATION Item 1. Legal Proceedings. We are, from time to time, subject to legal proceedings and claims that have arisen in the ordinary course of business. We are not currently a party to any legal proceedings that we believe are material with respect to our financial condition or results of operations. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. Our Annual Meeting of Shareholders was held on May 22, 2001 at which time certain matters were submitted to our shareholders for a vote. Below is a brief description of each such matter as well as the outcome of each vote. The shareholders elected the following persons to serve a one-year term as members of the Company's Board of Directors:

The shareholders ratified the appointment of Arthur Andersen LLP as the Company's independent auditors for the fiscal year ended December 31, 2001.

Item 5. Other Information. Subsequent Events: On July 8, 2001, we signed a definitive Agreement and Plan of Merger (the "Merger Agreement") with divine, inc., a Delaware corporation ("divine") and DES Acquisition Company, a Delaware corporation and wholly-owned subsidiary of divine ("MergerSub"). According to the Merger Agreement, divine will acquire us effective as soon as practicable after the closing date, which has not yet been set, through our merger with and into MergerSub, with MergerSub surviving and remaining a wholly-owned subsidiary of divine. The proposed transaction remains subject to the approval of our shareholders and to the extent required, the stockholders of divine. The date of our shareholders' meeting and the divine stockholders' meeting, if required, has not yet been determined. In anticipation of the shareholders' meeting and stockholders' meeting (if required), our Board of Directors and the Board of Directors of divine intend to solicit proxies by filing a combined proxy statement/registration statement on Form S-4 with the Securities and Exchange Commission. The proposed merger is intended to qualify as a tax-free reorganization and will be accounted for under the purchase method of accounting. Upon consummation of the merger, and except as provided below, each of the approximately 21.9 million outstanding shares of our common stock currently outstanding will be converted into the right to receive 1.30 shares of divine class A common stock (the "Exchange Ratio"). If the average per share closing price of divine class A common stock for the ten trading days ending two trading days prior to the consummation of the merger (the "Average Market Value") is $2.82 or greater, the Exchange Ratio will be adjusted to an amount equal to $3.653 divided by the Average Market Value. If the Average Market Value is $2.39 or less, the Exchange Ratio will be adjusted to an amount equal to $3.12 divided by the greater of the Average Market Value or $1.00. 14 15 If, pursuant to the above-described adjustments, more than approximately 28.5 million shares of divine class A common stock are to be issued to our shareholders in the merger, divine can elect to pay cash in lieu of such excess shares in an amount per share equal to the Average Market Value of divine class A common stock. However, divine has represented that it will not elect to pay cash in excess of 50% of the total consideration paid to all our shareholders. In addition, each outstanding option to purchase shares of our common stock that has an exercise price that, when multiplied by the Exchange Ratio, is less than or equal to the closing price of divine class A common stock on the day prior to the consummation of the merger will become exercisable at the adjusted exercise price for a number of shares of divine class A common stock equal to the number of shares of our common stock subject to the option multiplied by the Exchange Ratio. All our other stock options will be cancelled. As of July 8, 2001, there were outstanding options to purchase a total of approximately 3.7 million shares of our common stock, with exercise prices ranging from $0.43 to $20.88 per share, with a weighted average exercise price of $4.80 per share. divine has also agreed to reserve a number of options to purchase its class A common stock equal to 13% of the number of shares of divine class A common stock issued to our shareholders in the merger for future grants to our employees who become employees of divine after the merger is consummated. Each share of divine common stock issued pursuant to the Merger Agreement will be registered pursuant to a Form S-4 Registration Statement filed with the Securities and Exchange Commission. The Merger Agreement may be terminated under certain circumstances, including by eshare if at any time after the effective date of the Form S-4 Registration Statement, but prior to the date of our shareholders' meeting, the average per share closing price of divine's class A common stock for the previous ten trading days is less than $1.00. Under certain circumstances, termination of the Merger Agreement will require divine or eshare, as applicable, to pay the other party a $2,000,000 termination fee. The Merger Agreement contains representations, conditions, indemnifications, provisions, covenants and other provisions typical for similar transactions. The consummation of the Merger and the transactions contemplated by the Merger Agreement are subject to certain conditions, including approval by the our shareholders and the declaration of effectiveness by the Securities and Exchange Commission of the registration statement to be filed pursuant to the Securities Act of 1933, as amended, covering the shares of divine common stock being issued pursuant to the Merger. 15 16 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits The following exhibits are filed with this Report: Exhibit 10.1 Agreement and Plan of Merger, dated as of July 8, 2001, among divine, inc., DES Acquisition Company and eshare communications, Inc. Exhibit 10.2 Voting Agreement, dated as of July 8, 2001, between divine, inc. and Szlam Partners, L.P. Exhibit 10.3 Stockholder Agreement, dated as of July 8, 2001, among divine, inc., Szlam Partners, L.P. and Aleksander Szlam. Exhibit 99.1 Safe-Harbor Compliance Statement (b) Reports on Form 8-K None. 16 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. eshare communications, Inc. August 14, 2001 By /s/ Aleksander Szlam ---------------------------------------------- Aleksander Szlam Chairman of the Board and Chief Executive Officer August 14, 2001 By /s/ Glen Shipley ---------------------------------------------- Glen Shipley Chief Financial and Administrative Officer 17

ESHARE COMMUNICATIONS INC 10-Q